In September and October, at the height of the fears of the US sub-prime credit spreading to other markets, and of the dollar falling, mountains of cash came into India's stock market from overseas, as foreign institutional investors (FIIs) sought safety for the first time in emerging markets.
As a result, the Sensitive Index (or Sensex) put out by the Bombay Stock Exchange shot up from the 16,000 level to 20,000 and more in two months, and the Reserve Bank had to do record mopping up of foreign currency to prevent the rupee's dollar value from climbing even more than it has.
Then the tide turned. In November and December, the FIIs have been selling in the domestic secondary market, pulling out an estimated $5 billion during this period. Yet, the Sensex after going through a wobble has settled back above the 20,000 mark.
These figures would suggest that the stock market is going through an interesting transformation, mostly unnoticed. The hypothesis has to be that the stock market is no longer driven primarily by FII behaviour.
What is the evidence for this?
First, there is the entry into the market by some large public sector investors like Life Insurance Corporation and State Bank of India. Other insurance players, stuck with long-term cash, may be doing the same thing.
On top of that, the mutual funds have increased the funds under their management. Many of them have floated new fund schemes and received an enthusiastic response from the retail investor/public. Once it has been raised for investment, the money has necessarily to be deployed in equities, which has translated into fresh buying stocks by fund managers.
The combined effect of these developments has been to neutralise the selling by the FIIs, so much so that the Sensex has stayed where it was.
This signals a change in the Indian stock market, which has gained depth as different categories of institutional investors -- domestic and international, short- and long-term, etc -- have all become significant players. Given their different time horizons and objectives, some institutional players will be buying while others will be selling. This will be added to in some measure by the government deciding to allow charitable trusts to invest their corpus through the stock market, providing for another set of buyers who will enter the market, probably in stages.
And even more money will come into the stock market in the coming months as the new pension scheme for government employees gets into full swing. At the same time, however, the stock market regulator has also proposed the re-birth of short selling, albeit with some restrictions.
This will help create the counter-pressure required in a mostly bull market, and thereby contribute to market stability.
These are all positive developments. However, the fact remains that the FIIs still have an overwhelming presence in the Indian market, being the single largest category of investors after company promoters -- who usually do not play with their own holdings and therefore contribute little to trading volumes on the market.
If the risks that some observers see in this FII dominance (the doomsday scenario envisages wholesale pull-out by the FIIs, thereby destabilising stock prices, currency valuations, liquidity in the system and much else) are to be minimised, then there is only one way to go: do more of what has been done already, so that domestic participants become the lead players on the market, even as the market remains accessible to all comers.